1.6 Elasticity

Question 1

price elasticity of demand definition

Answer 1

the responsiveness of demand to a change in price

Question 2

PED calculation

Answer 2

percentage change in Qd/ percentage change in price

Question 3

PED is always…

Answer 3

negative

Question 4

why is PED always negative?

Answer 4

it reflect the law of demand (the inverse relationship between price and quantity demanded)

Question 5

price elastic demand

Answer 5

︱PED︱> 1
PED = big/small
relatively responsive demand

Question 6

price inelastic demand

Answer 6

︱PED︱< 1
PED = small/big
relatively unresponsive demand

Question 7

perfectly elastic demand

Answer 7

︱PED︱= infinity
unlimited demand at a fixed price

Question 8

perfectly inelastic demand

Answer 8

︱PED︱ = 0
PED = 0/x

Question 9

unit elastic demand

Answer 9

︱PED︱=1
PED = x/x
mathematical hypothetical

Question 10

the steeper the demand curve

Answer 10

the more inelastic the demand

Question 11

you can only visually compare PED if…

Answer 11

1. the scales are the same
2. the comparison is within the same two prices

Question 12

why isn’t unit elasticity of demand a straight line?

Answer 12

even though the gradient is constant, the PED at different points is actually different

Question 13

factors determining the price elasticity of demand

Answer 13

• necessities vs luxuries
• the proportion of income spent on good
• length of time
• number & closeness of substitutes

Question 14

why does increasing the length of time make demand more elastic

Answer 14

as time goes on consumers have the opportunity to…
1. consider their decision
2. get information on the availability and alternatives of the good

Question 15

what affects the number of substitutes for a good

Answer 15

how narrowly/broadly the good is defined - the narrower the definition, the greater the number of substitutes, the more elastic

Question 16

total revenue calculation

Answer 16

price x quantity sold

Question 17

relationship between total revenue and PED

Answer 17

elastic demand: increasing the price, TR falls
inelastic demand: increasing the price, TR increases

Question 18

price elasticity of supply definition

Answer 18

the responsiveness of supply to a change in the price

Question 19

PES calculation

Answer 19

percentage change in Qs / percentage change in price

Question 20

price elastic supply

Answer 20

PES > 1
PES = big/small

Question 21

price inelastic supply

Answer 21

PES < 1
PES = small/big

Question 22

perfectly elastic supply

Answer 22

PES = infinity
PES = unlimited change/ no change

Question 23

perfectly inelastic supply

Answer 23

PES = 0
PES = no change/unlimited change

Question 24

factor determining PES

Answer 24

• mobility of factors of production
• length of time
• spare (unused) capacity of firms
• the ability to store stocks (i.e. ability to stockpile)

Question 25

why can the ability to store stocks only affect PES over short periods of time?

Answer 25

because once stocks are released into the market, they play no role in PES

Question 26

income elasticity of demand definition

Answer 26

the responsiveness of demand for a good to a change in income

Question 27

YED calculation

Answer 27

percentage change in Qd / percentage change in income

Question 28

YED for normal goods

Answer 28

YED is positive YED = +/+ OR -/-

Question 29

YED for normal goods that are necessities

Answer 29

0 < YED < 1

Question 30

YED for normal goods that are luxuries

Answer 30

YED = big/small YED > 1

Question 31

YED for inferior goods

Answer 31

YED is negative YED = -/+ OR +/-

Question 32

in what aspects can PED help understand the impact of indirect taxes

Answer 32

1. determining the effectiveness of preventing consumption 2. the amount of per unit tax required to be effective 3. determining the effectiveness of raiding tax revenue 4. tax incidence

Question 33

what is tax incidence?

Answer 33

how much of the tax burden gets passed on to consumers and how much is absorbed by producers

Question 34

tax incidence when demand is inelastic

Answer 34

more of the tax burden is paid by consumers

Question 35

tax incidence when demand is elastic

Answer 35

more of the tax burden is paid by the producers

Question 36

in what aspects can PED help understand the impact of subsidies

Answer 36

1. determining the effectiveness of promoting consumption 2. the per unit subsidy needed to incentivize consumption 3. determining the burden on government expensive 4. subsidy incidence

Question 37

how do subsidies work?

Answer 37

lower producers cost of production to effectively shift the supply curve to the right

Question 38

subsidy definition

Answer 38

a cash payment to producers for each unit fo production

Question 39

what is subsidy incidence

Answer 39

how much of the subsidy gets passed on to consumers and how much is kept by producers

Question 40

inelastic demand on the impact of a subsidy

Answer 40

the subsidy will have a limited impact on the quantity sold -> ineffective @ promoting consumption --> larger subsidy needed to incentivise consumption ---> expensive government spending

Question 41

limitations of using PED to help firms make pricing decisions

Answer 41

- most firms are profit maximizers, not total revenue maximizers - it is hard to estimate the PED of a product for firms

Question 42

subsidy incidence when demand is inelastic

Answer 42

more of the benefit goes to consumers

Question 43

subsidy incidence when demand is elastic

Answer 43

more of the benefit goes to producers